The Kenya Shilling - Bobby McFerrin Firmly in Control of Analysis

So the 12th August 2017 edition of the East African (a Nation Media Group publication ) is reporting that the Kenya shilling is unshaken by poll jitters. I am not surprised. Actually I argued two days ago that such pseudo analysis will fill the air as business media looks for content that will make it look serious and analytical.

A better perspective would be reached if one was to take a deep dive beyond what the Shilling is trading at today. But don't bet on that happening; you will lose. Bobby McFerrin is firmly in control with his powerful message of "Don't Worry Be Happy". It worries me!

The Policy Choices We Confront - Some Random Macro Thoughts (A BitTechnical)

Now that Kenya has had a presidential election and the winner is being determined by the relevant agency, every pundit and pseudo-pundit (all expressing their prowess or lack thereof on television) is engaged in what econometricians would call  (for lack of a better word) mock out-of-sample predictions.

The very little time I have spend listening to their "sudden" wisdom, I haven't gotten any reason to imagine that any of them has a "model" to guide their prediction. I am therefore safe to assume that the said wisdom doesn't extend to their evaluation of the macroeconomic policy choices linked to either side once a winner is declared. 

That doesn't mean that on the business/economics side there are no quick, if casual, predictions (but those are not on TV, for such stuff doesn't sell at such a time). The easy one, where fake expertise is as always in display, is when people are falling on each other on how the Kenya shilling has been stable even on the verge of the presidential elections. Or that the stock market remains healthy despite low trading volumes.

The other is when an international rating agency is busy telling us the necessary, simultaneously sufficient, for the sovereign rating to be maintained. Reuters reports S&P arguing that Kenya's B+ credit rating and stable outlook won't be affected by its election as long as there is no repeat of the violence similar to the post 2007 vote.  On this I don't have to agonise, for I have my mind clear on how such views are motivated. As I recently argued, these are calculated guesses!

These casual economic observations force me to step back nearly four decades, precisely to 1979, when there was an important occurrence.  Don't get me wrong; I am not talking about the overthrow of the dictator of Uganda, Idi Amin in April 1979. Nor am I talking about Michael Jackson releasing his breakthrough album "Off the Wall" in August 1979.

Instead I am talking about the publication of Paul Krugman's seminal paper titled "A Model of Balance of Payment Crises". Krugman's formalisation of a balance of payment crisis hinges on the coexistence of an expansionary domestic credit policy and a fixed exchange rate regime.

If the central bank's monetary policy is predicated on some measure of money supply (in other words money demand is predetermined) then the only way to sustain an expansionary credit policy is through reducing foreign exchange reserves. But the central bank has a lower limit of reserves that it must hold.

If there is a pre-existing fiscal deficit (in other words the fiscal policy imposing an exogenous constraint), then the monetary authority has to adjust the rate of credit expansion (with, as noted, the effect of lowering the foreign reserves) to balance the budget. If this comes at the breaching of the lower limit of foreign currency reserves, then the foxed exchange rate regime collapses. This is the currency crisis that Krugman likes to joke as having invented (and not the real thing).

How does this relate to Kenya's policy choices at the moment? The lazy and obviously wrong answer is that such theory is at the very least irrelevant. Those with such inclination will no doubt make three arguments:

• One, our foreign exchange regime is free floating. Indeed it is, but if Bloomberg is to be believed, then there is a gag to the nominal exchange rate movement.
• Two, the Central Bank of Kenya's monetary policy is interest rate based. Indeed it is, but as I have argued before, with the re-introduction of interest rates capping the monetary policy tool is rendered impotent.  
• Three, we have adequate reserves and even a stand-by facility from the International Monetary Fund (IMF). True, but if our fundamentals are right, then the facility wouldn't be necessary (in other words, the very fact that we have the IMF facility is a signal of vulnerability). Even the adequacy of reserves needs to be seen on the back of the monetary authority's comportment towards the movement in the nominal exchange rate as reported by Bloomberg.     

Meanwhile, fiscal policy is looming large. The justification is that the fiscal deficit arises from funding necessary physical infrastructure that enhanced the economy's long-run capacity. As I have learned from a recent study published by the IMF (Working Paper WP/17/105 of May 217), the choice is between funding roads and schools.

I don't want to take the flavour from the study, so I will let it speak for itself:

"Why do governments in developing economies invest in roads and not enough in schools? In the presence of distortionary taxation and debt aversion, the different pace at which roads and schools contribute to economic growth turns out to be central to this decision. Specifically, while costs are front-loaded for both types of investment, the growth benefits of schools accrue with a delay. To put things in perspective, with a “big push,” even assuming a large (15 percent) return differential in favor of schools, the government would still limit the fraction of the investment scale-up going to schools to about a half. Besides debt aversion, political myopia also turns out to be a crucial determinant of public investment composition. A “big push,” by accelerating growth outcomes, mitigates myopia—but at the expense of greater risks to fiscal and debt sustainability. Tied concessional financing and grants can potentially mitigate the adverse effects of both debt aversion and political myopia".

 So the shilling may hang on, and S& P may maintain its sovereign rating. But for how long? That is the economic question that the country's political choice may have to be confronted with. And if there is a movement for the worse, it may be swift like a Wile C. Coyote moment - when he is falling down the cliff, it is when he least expects it (see below).

 

When the 'Business Daily' Falls in Love with a Narrative

Yesterday the Business Daily had some “breaking news”! A Citibank economist had proclaimed that interest rate capping is upsetting the Central Bank of Kenya’s monetary policy conduct.

The economist – David Cowan – knows what he is talking about; and his observations in the research note that underpins the story are entirely valid.
What is interesting, at least to me, is the timing of the decision by the Business Daily to give the story prominence.
First, it is not breaking news. When the Monetary Policy Committee (MPC) of the Central Bank Kenya (CBK) said as much in its communique of March27, 2017, it wasn’t news worth of Business Daily’s prominence.
 Instead, all we got was the nonsensical argument that the decision to retain the policy signalling rate – the Central Bank Rate (CBR) – which is also the base for capping at 10% was a reprieve to borrowers.
My colleagues and I have elaborately argued twice [here (March 2017) and here (June 2017)] that, if for no other reason, the capping of monetary affects monetary policy consequences; and the consequences of that is damning to the well-functioning of the money pricing regime and the economy as a whole.
But I guess I have been around the block enough to know how masquerade to thought leadership in newsrooms operate: it is not about the logic and the merit in the argument; it is who makes the argument and as a consequence how will it sell the newspaper for a day.
Second, it is a reflection of the thinking that is compartmentalised – monetary policy is now hamstrung is one compartment and banks are engaging in blackmail through reducing credit to the private sector is the other.
I must be quick to excuse such thinking, to the extent that it happens in the newsroom; the reason why I do so is because I do not expect a “general equilibrium” way of thinking – where one looks at all possible connections – to happen there.
If I am right is so arguing, then it is easy for me to see why people are now making the lazy argument of there being a nexus between banks’ decision to rationalise their branch network and the “blackmail” conspiracy theory.
What I know for sure is that the decision by a bank to open (and close) a branch or extent credit is tough to make than that of wring a careless newspaper story or a pretentious editorial like today's where there is an assertion that “removing the caps demands that all other distortions are dealt with at once”. 
One wonders whether there is really an understanding at the Business Daily of (a) what the distortions that they are talking are (b) whether it is practical to imagine that those distortions can be dealt with “at once” (c) how it doesn’t make any economic, even logical sense to start putting a sequencing (more accurately a condition) that the removal of the distortionary caps needs at happen once all the other distortions have been removed “at once” – why not remove all of them “at once” then?
 But hey, I am not naïve to expect a newspaper that has fallen in love with a narrative to let soberness come in its way.                    

"Inflation: Both Sides Have a Point"

What comes to your mind when you read the Business Daily's Friday 3, 2017 splash about how poor households are skipping meals in order to beat inflation? What was the essence of seeking the views of the Chris Kirubi and Donald Kipkorir?

This is what the duo had to say.

Kirubi: "It's the small people that the government needs to step in and cushion from rising costs".

Kipkorir: "I even don't know the price of fuel, food and such. I am never bothered by these price changes as they don't affect me".

When I saw the quotes attributed to the duo, I couldn't help but recall a column written by Economist Paul Krugman nearly 17 years ago in the New York Times where he said thus:

"If a presidential candidate were to declare that the earth is flat, you would be sure to see a news analysis under the headline "Shape of the Planet: Both Sides Have a point".

In other words, the story above was looking for balance in giving  the duo a chance to gloat about why the inflation thing is not about them - I naively used to imagine that business people need a stable operating environment as assured by low and stable inflation!

Crazy!

The Trageddy of a One Day News Cycle

On January 31, 2017, I published a Research Note that made some policy makers unhappy. In the Note, I observed thus:

"We therefore observe that the decision by the MPC to hold the CBR at 10.0 percent as justified
by the Committee’s argument that inflation is within the target range and previous decisions
need time to work through the economy was anticipated. While on that account the MPCs
decision seems justified, its assessment of the immediate term risks on price stability and other
macro  parameters  are  of  less  candour.  Consequently,  this  reflects  the  MPC’s  inability,  or
unwillingness, to provide forward guidance in its monetary policy signalling".

At that point in time, everybody who has an opinion on such matters - especially the pretentious business media - was fixated on the cost of credit, terming the MPC decision a reprieve to borrowers.

To many,  it didn't matter then that the capping of interest rates had dampened credit expansion as many of us had forewarned and that the main worry was macroeconomic stability.

It equally didn't matter that the MPC - in its wisdom or lack thereof - decided to hold its meeting a few hours before the release of  inflation numbers - the core policy target; this meant that the Committee chose to make a decision without the benefit of one crucial piece of information.

Fast forward to February and as I had anticipated Inflation hit the roof, busting the official target. Now everybody is wise. The editorials are roaring: "Inflation rise a wake-up call for policy makers".

The next MPC meeting is scheduled for March 27, 2017 - curiously three days before inflation numbers are published.

If the MPC does the right thing and adopts a tightening stance, the same wise people will predictable start talking about the cost of credit - as if that is all that matters!

While this is a tragedy of the one day news cycle syndrome - that coincides with the editorials' short  memory - is vindicates my argument on the folly of the CBK's choice of the Central Bank Rate (CBR) as the benchmark rate for capping  lending rates.

For those curious, the CBR is a policy signalling rate meant to balance the inflation gap (actual vis-a-vis the target) on the one hand and the output gap (actual output vis-a-vis potential output).

The CBR therefore has no business being linked to credit pricing. It is role is to signal policy intentions, and then be operationalized by a market rate (be it the interbank rate, repo rate, or even the Kenya Banks Reference Rate (KBRR) - which the MPC chose to suspend).

That is funny stuff right there!  

Yours Truly as a Talking Head!

Courtesy of the CFA Society of East Africa, John Randa (World Bank ) and I had this interesting conversation.